EU Daily | Europe’s Bank Signals It May Raise Interest Rates to Tamp Down Inflation
Posted by WARREN MOSLER on March 4th, 2011
So the ECB,
which is funding the entire euro zone banking system,
and for all practical purposes backstopping the funding of the national govts as well
to keep their funding costs manageable as they struggle with the terms and conditions of the austerity mandates,
That same ECB is now looking to raise rates, a proposal which is already working to increase the funding costs of those national govts.
They must think hiking rates is the tool to use to control the ‘inflation’ they are concerned about?
‘Inflation’ that’s come from tax hikes and relative value shifts in food and energy, as a foreign monopolist hikes crude prices and the burning up of our food supply for fuel hikes food prices?
Rate hikes that shift funds from borrowers, like the national govts they are supporting, to rentiers who will be getting the pay increase from higher rates?
And rising interest rates will require more austerity measures to offset the increased interest expense?
Yes, they also believe ‘inflation’ comes from elevated ‘inflation expectations’ but even that channel of causation, as far fetched as it is, has to be confused by the large output gap and general weakness of aggregate demand? Higher interest rates will somehow cause trade unions to soften demand for pay increases so their members can afford to eat?
Seems it goes back to the old Bundesbank dynamic, where the CB would threaten politically distasteful rate hikes if the govt didn’t tighten fiscal?
Well, today the ECB is already controlling fiscal, so it’s all moot.
But the old reflexes are still there.
Somewhat the like the old reflex with regard to export driven growth, but without the ideological option of buying dollars previously discussed.
So putting it all together, they have the export driven policy reflex without the dollar buying that’s undermining itself by driving the euro higher, working to limit demand from exports,
as the ECB both funds the financial structure and imposes austerity which is working against domestic demand.
And the rate hike reflex which won’t alter the price pressures from food, energy, and taxes.
And no telling what they may do next.
With their levels of unemployment, food price increases, and a general feeling that there are no ideas from on high to get them out of this mess, and large pools of newly arrived immigrants getting hurt them most, civil unrest is not impossible?
Maybe recognize that Europe is nothing more than a poorly managed theme park, and get a Disney exec to run it?
German Two-Year Yields Climb to Two-Year High on ECB Rate Bets
By Emma Charlton and Keith Jenkins
March 4 (Bloomberg) — German two-year government notes rose while their Greek equivalents fell, on concern higher borrowing costs may hamper the region’s most indebted countries, spurring demand for the euro zone’s safer assets.
Greece’s two-year yields reached the highest since May 10, the first trading day after the European Union and the international Monetary Fund announced the creation of a bailout fund to backstop the euro. European Central Bank President Jean- Claude Trichet said yesterday it’s “possible” that rates will rise at the central bank’s April meeting. His comments drove the German two-year yield up 23 basis points yesterday, the biggest increase since January 2009.
“There are some questions being asked about what tighter policy does for wider Europe, so that’s helping the bid toward core product,” said Eric Wand, a rates strategist at Lloyds Bank Corporate Markets in London. “Trichet was pretty clear that there would be a hike come April, so that’s going to underpin the German front-end going forward.”
The two-year note yield was two basis points lower at 1.76 percent as of 10:56 a.m. in London after reaching 1.84 percent, the highest since December 2008, according to data compiled by Bloomberg. The 1.5 percent security due March 2013 rose 0.035, or 35 euro cents per 1,000-euro ($1,387) face amount, to 99.49. The yield on German 10-year bunds, Europe’s benchmark government debt securities, was one basis point lower at 3.32 percent.
March 25 Deadline
Trichet will speak alongside governing council members including Mario Draghi and Christian Noyer at a Banque de France conference in Paris today. The ECB’s anti-inflation stance comes as European Union leaders approach a March 25 deadline for a reinforced plan to aid debt-strapped countries.
Greece’s two-year yields surged 24 basis points to 15.16 percent. The yield difference between German 2-year notes and Greek securities of a similar maturity was 13.41 percentage points, the widest since May 7, according to data compiled by Bloomberg.
Ten-year bunds were higher before a U.S. labor market report that is forecast to show employers added 196,000 workers last month, after a 36,000 gain in January, according to the median forecast of 84 economists surveyed by Bloomberg News. The report may also show the jobless rate increased to 9.1 percent from 9 percent.
“Right in front of payrolls data, people aren’t going to want to set too much risk on their books,” Wand said.
German-U.S. Spread
The yield difference, or spread, between German two-year notes and U.S. securities of the same maturity, narrowed four basis points to 98 basis points. It reached 103 basis points yesterday, the highest since Dec. 30, 2008, as traders added to bets that the European Central Bank will raise borrowing costs before the Federal Reserve.
The Frankfurt-based central bank, which left its key rate at a record low of 1 percent yesterday, is concerned about so- called second-round inflation effects, when companies raise prices and workers demand more pay to compensate for soaring energy and food costs, Trichet said. Euro-area inflation accelerated to 2.4 percent last month.
Euribor futures fell, pushing the implied yield on the contract expiring in December 2011 up two basis points to 2.18 percent. Earlier it rose to 2.215 percent, matching the highest since Feb. 22, 2010, as investors added to bets that the ECB will increase borrowing costs.
Forward contracts on the euro overnight index average, or Eonia, signal investors think the ECB will increase the key rate 25 basis points by its July meeting, Deutsche Bank AG data shows.
March 4th, 2011 at 11:49 am
I’m confident that that was actually suggested at the ECB stockholder’s meeting, but participants were so distracted swapping ideology cards that no one even noticed.
PS: a current joke describing economic policy meetings has borrowed a number from comedians
Guy wanders into an auditorium where people in suits are shouting numbers and furiously executing policy. He watches, baffled, then asks what’s going on. Someone tells him it’s an economic policy mtg, and they all know the only possible options so well that they’re simply referred to by number.
Sure enough, someone from Harvard climbs on stage and shouts “14″, which draws an uproar from the audience and triggers significant market fluctuations. The newcomer watches in amazement as the process is repeated again & again, with different numerals between 1-100.
Finally, he thinks, “Hell, even I can do this,” runs up on stage and yells “47!” Nothing happens, there’s complete silence, everyone stares, and markets are temporarily closed down by authorities.
He slithers off stage in embarrassment and asks his lone contact “Where did I go wrong?”
Before walking away, his contact sneers at him and says “The impact of BS is all in the delivery.”
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March 4th, 2011 at 4:05 pm
Maybe recognize that Europe is nothing more than a poorly managed theme park, and get a Disney exec to run it?
I love it. They can raise money by charging a head tax to handle overhead, instead of paying for the attractions separately, and make even more money on the concessions, souvenirs, and trademarks. Beats what they are doing now. :)
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March 4th, 2011 at 5:03 pm
Krugman’s take
The Madness of Jean Claude Trichet
They are looking at supply-side price increases as demand-side and applying monetary policy that has failed demand-side inflation since it uses unemployment as tool. Europe on the brink?
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Ramanan Reply:
March 4th, 2011 at 6:53 pm
Tom,
The present policies followed by the Euro government leaders are confused to the core. The alphabetic soup of SPEs such as EFSF will make the problems worse because fiscal transfers are what is needed now.
On a slightly tangential note…
I somewhat like Barry Eichengreen, thought I understand he gets many things wrong.
Here is an article by quoting him
http://www.google.com/search?sourceid=chrome&ie=UTF-8&q=Extreme+Measures:+The+Euro+Breaks+Up OR
OR http://www.google.com/search?sourceid=chrome&ie=UTF-8&q=Extreme+Measures:+The+Euro+Breaks+Up w/o account.
I believe the only way to save it from flying apart is to establish a central government or unify the nations into one.
Don’t think its on the brink … The ECB will do whatever it takes to save the game… forced to.
But you never know … Ireland’s financial system is in such a crazy state…. and of course its due to massive deregulation. Ireland is a tax haven ?
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Tom Hickey Reply:
March 4th, 2011 at 8:54 pm
I think that they made a huge bet and thought they would have have the time and space to work it out, ending up with a United States of Europe. But economic time and political space are collapsing in on them. The population was never solidly behind the idea, and many people are getting less enchanted by the day.
If the news is being reported correctly, the political pressure is mounting in Germany, for example. I said from the beginning that if this falls apart it will be because the Germans don’t want to carry the rest of Europe when they think they can do fine on their own.
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Mr. E Reply:
March 5th, 2011 at 1:02 am
“I think that they made a huge bet and thought they would have have the time and space to work it out, ending up with a United States of Europe. But economic time and political space are collapsing in on them. The population was never solidly behind the idea, and many people are getting less enchanted by the day.”
I very much agree with this.
I’d also put out there the idea they have deliberately played up default probabilities for the non-core countries as their only real weapon in the “currency war”. The Euro currency has significant restrictions compared to other currencies. The countries cannot deficit spend very easily, their central bank cannot easily purchase issued debt, they don’t have a centralized “reserve currency” (cough- currency manipulation- cough) program.
In the context of the current conventional wisdom – where a country should attempt to export their way to growth – a weak currency is a good currency. But the Euro countries have zero conventional weapons to make their currency weak.
There is very little chance that Germany will cause this to explode. I’ve seen many articles in the German press about the usefulness of the Euro. Additionally, the business community is getting behind the Euro big time – all of the big companies are coming out and saying “The reason our confidence is so high is that the Euro makes our products 20% cheaper than they should be.”
So while I’ll grant there is some danger from Germany, the danger is probably less than most people think
So they participated in the war the only way they could – by threatening default. Note that Trichet and the rest know perfectly well they could purchase bonds from Ireland and the rest at levels far below the current market rates, but choose not to. We need to ask why.
A reasonable answer is they like having a weak Euro.
Ramanan Reply:
March 5th, 2011 at 4:40 am
“I think that they made a huge bet and thought they would have have the time and space to work it out, ending up with a United States of Europe. But economic time and political space are collapsing in on them. The population was never solidly behind the idea, and many people are getting less enchanted by the day.”
Yes I agree. What I am saying is that “absent agreeing on the only solution” … the region’s problems will keep getting worse.
Leaving the EZ is not the easiest legal task. Debts have to be paid in the Euro. A highly devalued currency will make this option difficult.
Interaction with the rest of the world would require a nation to become a member of the IMF and the IMF wouldn’t like defaulting on debts.
Tom Hickey Reply:
March 5th, 2011 at 11:40 am
Ramanan: What I am saying is that “absent agreeing on the only solution” … the region’s problems will keep getting worse.
Agreed. What I am saying is that this will become a political problem. If governments change and new regimes are unfriendly to Europeanists, then anything is possible. Many people realize that the austerity program is in the interest of the banks and politicians, not them. If time and space collapse and the situation implodes, then all bets are off.
The question seems to be whether this can be cleared before it reaches Spain.
March 5th, 2011 at 2:22 am
The most likely answer is still “47!”
That was the special policy answer provided to the ECB by the CERN data center, before they “ran out of money” & closed down again.
ps: If they did go the theme park route, I’d lobby to have a dedicated “economist” ride, and make sure it was down 365 days per year. They could have Marie Antoinette declare “Let THEM stand in line!”
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March 5th, 2011 at 7:17 pm
Ramanan: “Leaving the EZ is not the easiest legal task. Debts have to be paid in the Euro. A highly devalued currency will make this option difficult”
Yes; but surely if Germany left the new DM would trade at a premium to the EUR. Export competitiveness would fall, but servicing EUR debts would not be a reason for G not to leave the EZ.
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March 6th, 2011 at 11:27 am
[...] David Beckworth sports the 'black eye' metaphor; Kantoos is somewhat more explicit in his language; and Warren Mosler goes for the Disney theme.And then I see that one of my favorite blogs, the Eurointelligence blog, [...]
March 6th, 2011 at 12:41 pm
With regard to inflation, it’s not just oil and corn that is sky rocketing. It’s virtually every commodity out there (with price hikes of finished goods already starting to be passed through). How can one distinguish this from real inflation. It seems like just a semantic difference (i.e. increasing relative values vs inflation). Can someone clarify this, because to the average observer (me), it sure feels like inflation. Thanks.
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Tom Hickey Reply:
March 6th, 2011 at 1:15 pm
If commodity/energy price rises pass through to finished goods and put pressure on wages. it is inflation. This is supply-side inflation rather than demand-side, so treating it as demand-side by making money more expensive would be counterproductive, since it doesn’t address the real problem.
Increasing rates increases the cost of capital, which restricts productive investment when more investment is needed to increase supply in order to counter supply-side inflation due to shortages. Moreover, increasing rates adds net financial assets to the economy, increasing demand when supply is short, putting more pressure on prices.
Supply-side inflation becomes runaway inflation due to hoarding. Many government are now hoarding food in anticipation of higher prices, which is driving prices higher. Countries in which a substantial portion of income is committed to food and fuel cannot afford prolonged shortages for fear of revolt. This encourages speculators to pile on, and even ordinary people to stockpile.
Supply-side inflation is the reverse of deflation, where everyone is postponing purchases waiting for lower prices. With supply-side inflation, people are hoarding in anticipation of higher prices.
With supply-side inflation either new supply must be developed, or a lower standard of living accepted, i.e., the real wage falls, or wage pressure gets out of hand in trying to keep up with rising prices. In the latter case, costs including labor spiral up and so do prices, encouraging more hoarding.
Then government is faced with few choices, institute rationing, impose wage and price controls, or set very high rates in order to stifle business and create a recession. But none of these address the real problem which is supply, and all create their own problems.
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